Companies have realised their 80% of profits come from 20% niches; so it’s vital to recognise those niches

By: | Published: September 3, 2018 1:22 AM

Identifying the 20% is very important in our professional and personal life, and our core competency, skills, interests, friends, etc. There are many misinterpretations of the 80/20 rule.

Companies have realised their 80% of profits come from 20% niches; so it’s vital to recognise those niches

In 1906, Italian economist Vilfredo Pareto observed that the 80% of land in Italy was owned by 20% of the population. What’s more, Pareto observed that 20% of the pea pods in his garden contained 80% of peas. He continued his search about the 80/20 fraction and found that 20% population in the world owned 80% of wealth. This is how Pareto created a mathematical formula to describe the unequal distribution of wealth in the world. In the late 1940s, the great management thinker Joseph M Juran attributed the 80/20 rule as “vital few and trivial many”. He called the 80/20 fixture as the Pareto principle, which is considered as a useful tool to help people prioritise and manage work.

Look at organisations—80% of a company’s profits come from 20% of its customers; 80% of a company’s complaints come from 20% of its customers; 80% of a company’s profits come from 20% of the time its staff spend; 80% of a company’s sales come from 20% of its products; 80% of a company’s sales are made by 20% of its sales staff. In business, the 80/20 rule is used to help managers identify problems and determine which operating factors are the most important and should receive the most attention based on efficient use of resources; they should be allocated to address the input factors that have the most effect on a company’s final results. The moment the 20% is recognised, the trivial 80% can be sorted out without much fretting. Juran’s initial work identified that 20% of flaws cause 80% of problems. Project managers know that 20% of the work (the first 10% and last 10%) consumes 80% time and resources. It is astonishing but you can apply the 80/20 rule to almost anything—from science to management to physical world.

In our personal lives also, roughly 80% of the effects come from 20% of the causes. Have you observed that we use 20% of clothes in our wardrobe regularly, and the balance 80% are rarely used by us? Also, 20% of our friends make up 80% of our social life; 20% of our personal problems consume 80% of our energy and time; 20% of stocks give us 80% profits. You go to book a railway ticket, airline ticket, pay electricity bills, go to a bank or a hospital, anywhere … if you observe keenly, you will see that 20% of the staff takes on 80% responsibilities. Similarly, police investigations reveal that 80% of road accidents are caused by virtually 20% of drivers and that 80% of crime is committed by 20% criminals.

Jack Welch applied the 80/20 rule during his 20-year leadership at General Electric. Welch had his own version of 80/20, designed to weed out the trivial many and focus on the vital few. He broke staffing down to a ‘vitality curve’ of three segments. His A-list consisted of the top-tier (20%) who performed the best and earned the biggest bonuses. The B-list (60%) included managers with a potential to rise to the top. The C-list consisted of people who were positioned at the bottom and were eventually dismissed (20%). Welch only believed in results. Here’s what he said about downsizing: “Strong managers who make tough decisions to cut jobs provide the only true job security in today’s world. Weak managers are the problem. Weak managers destroy jobs”.

In progressive companies such as Hewlett-Packard, Google and 3M, the staff is supposed to do the assigned job in 80% time, the rest of 20% time the employee can work on whatever he/she likes. This brings in some advancement to the company. What does this mean? It means these companies use the 20% silver lining for motivating their staff to do innovative things.

Organisations have realised that their 80% profits come from 20% niches, and it’s vital for them to recognise those niches—like Jeff Bezos did with Amazon. The realisation came when, at Amazon, they saw that 20% of Amazon US customers shop there once a week, and 80% of Amazon US customers shop there once a month. Amazon identified those customers and showered them with attention, deals, gifts, etc. They are treated as VIPs. Progressive organisations spend efforts on identifying their 20% niches—VIPs. Only those 20% niches deliver an outstanding return.

Identifying the 20% is very important in our professional and personal life, and our core competency, skills, interests, friends, etc. There are many misinterpretations of the 80/20 rule. Some result from the coincidental 100% sum. Some result from a logical fallacy, i.e. if 20% of inputs are most important, then the other 80% must be trivial.

The actual implied application of the 80/20 rule is to focus on identifying the inputs with the most potential productivity and pursuing those causes first. Managers must, therefore, make decisions about how to allocate scarce resources such as time, finances, labour and capital equipment, among others. The 80/20 rule suggests that it’s important for managers to understand which inputs produce the greatest results.

The 80/20 rule doesn’t mean that exactly 80% and 20% proportions are necessarily invariable in every case. If the manager of a financial advisory firm knows that 70% of the firm’s revenue comes from 10% of its clients, then the firm should focus its efforts on those 10% clients foremost. That creates most efficient use of resources. It’s a matter of opportunity cost, in other words.

By- Vidya Hattangadi. Management thinker and blogger.

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